Types of Financial Institutions

A financial institution is a corporation that facilitates the supply and circulation of money through transfers from  lenders to borrowers. It is an institution that deals with financial transactions such as investments, deposits, loans, and foreign currency exchange. It includes a wide range of companies whose operations involve financial services, such as insurance companies, investment banks, brokerage firms, and trust companies. There are several types of financial institutions:

  1. The Central Bank
  2. Commercial/Retail Banks
  3. Investment Banks
  4. Savings and Credit Cooperative Societies (SACCOs).
  5. Microfinance Lending Institutions
  6. Insurance Companies
  7. Capital Markets

The Central Bank: A central bank is a public institution that is responsible for implementing monetary policy, managing the currency of a country, or group of countries, and controlling the money supply. The functions of the Central Bank include:

  • To promote financial stability by regulating financial institutions
  • Regulating the operations of commercial banks
  • Implementing monetary policies to control money supply and inflation
  • Manages the country’s exchange reserves
  • Manages government’s domestic debt by issuing treasury bills and bonds
  • Regulating currency
  • Acts as the lender of last resort – commercial banks borrow from central banks.
  • Controlling credits
  • Protecting the interests of depositors and investors.
  • Acts as government’s bank, agent and advisor

Commercial Banks: Another important type of financial institution is a commercial bank. This is a financial institutions that issues loans and certificates of deposits, takes deposits, and provides savings accounts to customers. They make money through loans, mortgages, and transaction charges. They act as financial intermediaries between depositors and borrowers because they use customers’ deposits to lend to borrowers. They play an important role in the economy because they create capital, provide credit, and enhance liquidity in the market.

The Central Bank imposes reserve requirements on commercial banks. This means that banks are required to hold a certain percentage of their consumer deposits at the central bank as a cushion if there’s a rush to withdraw funds by the general public. Some of the functions of commercial banks include:

  • Accepting Deposits
  • Providing loans
  • Promoting liquidity through credit cash
  • Providing interest-earning savings accounts
  • Discounting bill of exchange
  • Providing overdraft services
  • Purchasing and selling securities

Investment Banks: This type of a financial institution provides financial services for corporate and institutional customers, such as investing and raising capital and arranging mergers and acquisitions. Investment banks act as intermediaries in large and complex financial transactions. Commercial banks may have investment and retail banking sections; but investment banks can operate alone without providing retail banking services. Investment banks do not accept deposits like commercial banks. An investment bank also deals with the trade in bonds and securities of companies. They can buy new securities from a company and sell them to investors in smaller units. There are over 20 investment banks in Kenya such as Kingdoms Securities, NIC, Diamond Trust Bank, UAP Old Mutual, ABC Capital, Equity Investment Bank, etc.

Some of the functions of an investment bank include:

  • Acting as a Financial Advisor for investors
  • Underwriting stocks and bonds
  • Facilitating mergers and acquisitions and offering advice on the same
  • Providing risk management services to corporations
  • Conducting research on the financial market
  • Structuring derivatives
  • Carrying out money market operations

Savings and Credit Cooperative Societies (SACCOs): Savings and Credit Co-operatives (SACCOs) are community membership-based financial institutions that are formed and owned by their members in promotion of their economic interests. These institutions mobilize and intermediate savings exclusively with in their membership under the Sacco Societies Act and they are regulated by the Sacco Societies Regulatory Authority (SASRA).

SACCOs are non-profit financial cooperatives owned by their members and governed by a member-elected board of directors. To join, individuals, businesses or savings groups must complete the necessary paperwork and purchase a minimum number of non-refundable shares. They also commit to a minimum monthly savings contribution. Although many SACCOs were originally informal community savings groups, the government’s regulatory framework now covers SACCOs, and once licensed, they are formal financial institutions.

Some of the roles and functions of a SACCO include:

  • Offering savings accounts and loans – deposit based loans. You save for six months and you are eligible to borrow.
  • Provide low-income families with safe place to save their income
  • Allows members to join groups to pool funds

Microfinance Lending Institutions: Microfinance is another type of financial institution that provides banking services to unemployed or low-income individuals or groups who otherwise would have no other access to financial services. Microfinance lending institutions are alternative forms of providing financial services such as loans and deposits to individuals who have little access to the formal commercial banks. It is a provider of credit in smaller quantities to serve small businesses and households who do not have security or employment status to guarantee loans in larger financial institutions. Examples of microfinance lending institutions in Kenya include KWFT, Faulu, Okash, and Platinum Credit.

Insurance Companies: insurance companies are financial institutions that enable businesses and individuals to transfer risks or losses. They take on risks in return for payment of premiums. Customers pay regular premiums such as monthly or annually, and the insurance company compensates them in case of a loss or injury. Some of the insurance services offered by such financial institutions include: life insurance, health insurance, accident cover, car insurance, fire insurance, property insurance, and disability insurance. Insurance companies in Kenya include: Jubilee Insurance, Britam, Allianz, AON Minet, APA Insurance, etc. These organizations are important because they protect people from losses, help businesses to recover losses, boost the economy by saving businesses, recovering lost property, and improving the wellbeing of individuals.

Capital Markets: Capital markets or money markets are financial systems where capital is raised through shares, bonds, debentures, etc. They are places where investors engage in buying and selling of financial securities such as stocks and bonds. The Nairobi Stock Exchange (NSE) is a good example of a stock market where the shares of companies are traded. Some of the companies listed in Nairobi Stock Exchange include Safaricom, Equity Bank, KPLC Cooperative Bank, Total, and KenGen. Traders in the NSE buy shares to benefit from capital gains and dividend payments. Capital gains are the profits that a person receive when they sell shares above the amount they used to buy them; while dividends are the share of profits that the company distributes to shareholders.

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